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It’s basically the best profitability metric for development. You’re assessing whether the project is viable today, and how much of your profit is coming from inflation. 99.9% of the time your inflation metrics are wrong, and the other 0.01% is just fluke.
You’re developing a building for $100. You believe your market rent today is $10 and your expenses are $5. Your untrended stabilized NOI would be $5 PSF, and untrended RoC is 5%.
In a model, you’re going to be inflating those numbers for when the lease-up happens. So let’s say you lease it up a year from your start date, and your rent and expenses both grow by 3%. Your leased up rent will be $10.30 and your expenses will be 5.15, bringing your NOI to $5.15. Your cost basis is still $100, and your trended RoC is 5.15%.
Trending just means growing. So your untrended NOI is just your NOI assumption today with no growth. Your trended NOI is the first stabilized year of NOI, which would include your market rent / expense growth assumptions.
And the reason the distinction is important (because I think that's what you're really asking), is that an untrended ROC is a simple evaluation of a project based on variables that are known (costs; some opex) and variables you can be pretty confident about (rents; the rest of opex). If a project looks good on an untrended ROC basis, in the development world that's pretty bulletproof. Development still has a metric f-ton of risk, but you can feel pretty good about the risk you are taking. The minute people start "trending", to me that is an indication the untrended ROC was too thin and they need to introduce additional variables to make the comparison to market cap rates look better. For example, Developer Bob is looking at a project with an untrended ROC of 5.8% and market cap rates of 4.75%. Knowing that capital sources won't like that little of development spread, Developer Bob "trends" his rents and expenses 3%/yr over his assumed two-year development period. This moves his return on cost to 6.15%. Still not great, but looks much better than 5.8%. The risk, though, is you are now introducing a totally unknown variable like inflation into the equation to justify a thin project. If NOI growth over the two-year construction period was 3%+/yr, then you are fine.
I like your explanation here so I have a question:
What kind of UYOC do you/does your firm want to see?
For my shop, it’s north of 7% for acq and north of 8% for dev
Hard to give it just one number. I'd say generally, I want to be 125-150bps above market cap rates on a development and on acquisitions I want to stabilize above my mortgage constant. If I'm taking a lot of risk on an acquisition, then I'll need more. If I'm buying a core plus acquisition, I can get by with less.
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Dude you are gonna confuse people. That is not how you calculate return on cost on non condo deals.
Untrended return on cost = stabilized NOI today / total project cost
Trended return on cost - stabilized NOI in the year you stabilized / total project cost.
Youre describing the project margin. Project margins are their own metric most useful in condo projects as you outlined.
On rental development my firm differentiates between yield on cost, or development yield, and return on cost. But just googled and seems like I’m in the minority so my bad!
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